Telecom: The Merger Is The Message

-- Net technology is replacing old methods, ushering in an era of souped-up services
-- Distinctions within the industry are blurring as outsiders make inroads

January 10, 2005, 12:00 AM EST

Last year ended with a bang in telecom. During the final three months, Cingular closed its $41 billion acquisition of AT&T Wireless, and Sprint (FON
) announced a $35 billion mega-merger with Nextel Communications (NXTL
). At a time when interest in traditional telecom companies is as rare as rotary phones, mergers are a sign of the profound changes afoot. "These kinds of deals create enormous opportunities to rethink the whole telecom sector," says Francis McInerney, managing director of consultant North River Ventures LLC.

By bulking up and bearing down, companies are sparking innovations that will transform communication. Wireless voice calls are just the start. More and more, mobile phones will be used to exchange e-mail, music clips, and even video. Likewise, Internet technology will replace old-fashioned phone gear, ushering in an era of souped-up services. Consumers will get voice mail on their PCs and all-you-can-eat phone service for under $25 a month, while businesses hand out mobile phones to road warriors so they can receive calls and e-mail just as if they were in the office. Says Randall L. Stephenson, COO at SBC Communications Inc. (SBC
): "2005 is going to be a very transformational year. You'll see the lines between services really begin to blur."

The distinctions among industries will get fuzzy, too. In 2005, telecom giants Verizon Communications Inc. (VZ
) and SBC will pursue licenses to market cable TV. AT&T (T
) plans to market security software to corporate customers. Comcast (CMCSA
) and other cable players are barreling into residential phone markets, and even sports power ESPN expects to unveil hip mobile phone offerings. "Telecom service as we know it is about to explode," says Richard Siber, a wireless expert and founder of SiberConsulting LLC.

The dust-up should serve as an industry catalyst, as new services at lower prices spill into the marketplace. Revenues from all U.S. communications services are expected to climb 6%, to $347.5 billion, in 2005, according to researcher Gartner Inc. (IT
) That's despite a decline in traditional voice service to $131.1 billion, down from $133.5 in 2004. Emerging services will drive spending. Wireless revenues are forecast to rise 11%, to $122.5 billion, while revenues from broadband and other data services are projected to rise 12%, to $93.9 billion.

Competition in those markets will grow even keener. Comcast Corp. is leading a consortium of cable operators that is exploring ways to break into wireless services. There's a strategic reason for the move: The cable companies are offering home phone service with Internet protocol technology, but without a mobile offering, they lack an essential element of the telecom bundle. The cable companies are trying to work out a partnership with Sprint Nextel or possibly T-Mobile USA (DT
) to sell consumers a dual-mode phone that would handle their IP calling service inside the house and switch to cellular systems outside. AT&T will unveil a similar service this year.

The scrum may spark more consolidation. Cable companies could consider acquiring a wireless company if the partnership approach fails. Separately, Verizon Wireless may look to gobble up a midsize player, such as Alltel (AT
) or U.S. Cellular Corp. (USM
), now that Cingular Wireless LLC and Sprint have bulked up. And while SBC and BellSouth Corp. (BLS
) are focused on helping combine AT&T Wireless with Cingular, which SBC and BellSouth co-own, SBC might not be finished. CEO Edward E. Whitacre Jr. has made no secret of his desire to own Cingular outright. "Of course I wish I owned it all," he told BusinessWeek in October. That could happen by his buying BellSouth's stake in Cingular or buying BellSouth itself. BellSouth says it's not interested in being acquired and doubts that regulators would approve such a deal anyway.

Behind the intense positioning is a simple proposition: Mobile devices may evolve into the primary tool for managing work and play. The number of U.S. wireless subscribers will surpass 180 million next year. And IDC says customers will dole out $83 million -- a 28% jump over last year -- to send photos and video clips, surf the Net, and zap e-mails.

Services are growing ever more advanced. AT&T (T
) is testing a service it hopes to unveil by yearend that will allow corporate users to whip out handheld computers, connect to a corporate database, manipulate spreadsheets back in the office, field e-mail, or hold a videoconference -- all while 30 miles away from a radio tower and without a risk to security. "That's very powerful," says AT&T's chief strategist, Eric Shepcaro. "It's a real enhancement to productivity."

The battle among providers means lower prices, too. Consider the impact of tiny Vonage Holdings Corp. By deploying voice over Internet protocol (VoIP) to offer inexpensive phone service, Vonage, unknown a year ago, is now the fastest-growing U.S. phone company. It's adding 30,000 customers per month, with a total of about 300,000 at the end of 2004.

TURF WARS

But Vonage has competition from some unlikely quarters. AT&T has embarked on a price war with the upstart, resulting in each lowering prices a couple of times in 2004 before bottoming out at less than $25 a month. Cable operator Cablevision Systems Corp. (CVC
) says it's adding close to 30,000 phone customers per month. Time Warner Cable (TWX
), meanwhile, says it's signing up about 40,000 phone subscribers per month. In all, 1 million folks are using VoIP technology in the U.S. That's a fraction of the 113 million-line residential market, but Yankee Group (RTRSY
) forecasts such services will win 17.5 million residential users by 2008.

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To counter this encroachment on their voice territory, the telcos will unleash spiffy new video services. SBC'S Whitacre, for example, plans to spend $800 million in 2005 to make video service available to more than 2 million homes. Verizon also will spend lavishly to unveil TV programming. Meanwhile, SBC's Net-based technology will let users choose the camera angles in a football game, read and hear e-mail on the big screen, and completely customize their onscreen TV menu. "This is not sci-fi stuff," says SBC's Stephenson. As long as the service companies keep the innovations coming, there's little danger that customers or investors will wander away.